Risk Management

Abstract

The processes of liberalisation and globalisation have seeped into the economic fabric of all nations across the world. Even the countries which were largely closed to the external influence on their economic system have opened up in terms of trade and investment. It is a shared perception of economists and researchers that free market system and liberalisation of business bring about higher growth and widespread development. In such a system, typically, business firms are able to raise resources at a global level as well as market their products across countries.

Before the year 1991, India remained a relatively closed economy, permitting only limited economic transactions with other countries. The macroeconomic policy of 1991 played a major role in India’s economic progress in the 1990s and beyond. But the questions arise: do the processes of liberalisation and globalisation/internationalisation create new risks? If they do, what are these risks? And what is done or can be done to mitigate these risks? The answer to the first question is affirmative, meaning thereby, that international operations have all those risks that are inherent in purely domestic operations and, in addition, they give rise to new risks such as country or political risk, exchange rate risk and interest rate risk. Risk management is the process of identification, assessment and prioritisation of risks followed by coordinated and economical application of resources to minimise probability and/or impact of adverse events or to maximise the realisation of opportunities.

These risks may be encountered more by companies in private sector as they are likely to have greater external orientation. The available literature does not indicate a comprehensive inquiry into globalisation and its resultant risk dynamics on a large corporate data set. Hence, it was necessary to ascertain from the finance managers their current practices of risk management and also perceptions about the future practices in this regard. Consequently, this chapter analyses and discusses the survey findings relating to the management of risks resulting from international operations.

The sample companies are amongst the largest companies in India with substantial international exposure in terms of size of transactions. Yet their holding pattern still remains dominantly domestic. This factor could have been responsible in part for the relative insulation of the Indian economy in the aftermath of the financial crisis originating in the USA in the year 2007–2008. Though the Indian economy has faced a slowdown, the profitability of sample companies has remained at a reasonable level. An overwhelming majority (96.42 %) of companies respond that risk is understood in its entirety by the company and measures are taken to mitigate it. This is an indication of the sophisticated risk assessment and management practices being followed by the sample companies.

The sample companies would like to reduce political or country risk by incorporating a risk premium in the cost of capital. Amongst other measures, creating a joint venture with an enterprise of the host country is the most preferred one. As regards exchange risk management, in case of anticipated depreciation, companies sell local currency forward, borrow locally and invoice exports in foreign currency and imports in local currency. In the case of anticipated appreciation, the most likely ways are to buy local currency forward and to reduce local currency borrowing. From the survey, it is apparent that the sample companies are only using netting and back-to-back swap (internal techniques of exchange risk management) in any significant manner. As regards the use of external techniques, forwards are the most preferred, followed by currency swaps, currency options and currency futures. Exchange risk management is organised by internal teams as well as with the help of outside institutional consultants. The survey revealed that sample companies are faced with interest rate risk and they would like to use newer instruments including derivatives such as interest rate options, swaps and futures as they become more and more prevalent in the market.

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